Congress should follow Texas’ lead in ending business taxes

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“There are no great limits to growth because there are no limits of human intelligence, imagination, and wonder.” – President Ronald Reagan.

Imagine governments without general business taxes. Imagine many businesses wanting to open with growing consumer demand. Imagine people not bearing the ultimate burden of business taxes.

Congress is appropriately discussing cutting the federal corporate income tax from the highest in the industrialized world at 35 percent to a more respectable 20 percent. However, the 85th Texas Legislature looks to make Texas the leader in America—and even the world—in tax policy by ending the business franchise tax.

Business taxes in Texas date back to the late 1800s, with the latest version being the franchise tax. It was a poor tax and was made worse in 2006 in response to an unconstitutionally flawed property tax system. Instead of enacting an efficient solution, the legislature reformed the franchise tax to deal with a problem that created another problem commonly called the “margins tax.”

The margins tax forces businesses to calculate their tax liability from the product of the lowest of four tax bases dependent on their gross revenue, hence the term “margins tax,” and two tax rates. This unique tax worldwide can require businesses with a net loss to submit the tax if revenue is above $1 million, pushing them further in the red.

It doesn’t take a tax specialist or a Ph.D. economist to know that the margins tax, which is estimated to collect $7.8 billion or 7 percent of total tax collections in the upcoming 2018-19 biennium, is bad policy. While there are differing opinions on how to eliminate it, there’s a general consensus from both sides of the aisle to do so.

While SB 178 would end the margins tax on Jan. 1, 2018, the worry by some legislators of limited taxes available to fund essential government services this session gives the phase out approaches in SB 17 and HB 28 the most attention.

Of course, like most governments, Texas doesn’t have a tax revenue problem, it has a spending problem, as spending is up 11.8 percent above population growth plus inflation since 2004. By controlling spending and considering the economic growth generated without the tax to balance the budget, immediate elimination of the margins tax is possible.

SB 17 is a trigger bill whereby half of the estimated general revenue for the upcoming biennium that exceeds a 5 percent increase from the prior biennium would reduce the margins tax rates each period until elimination. This reform is estimated to cut the tax rates in the 2020-21 budget for a total taxpayer savings of $1.1 billion.

HB 28 would use the lesser of either surplus dollars at the end of a fiscal period or $3.5 billion to buy down the margins tax rates. The estimated ending balance for the current biennium of $1.5 billion could have been used this session.

These steps would substantially improve the competitiveness and prosperity in Texas.

The Tax Foundation ranks Texas’ business tax climate 14th best nationwide. However, if Texas eliminates the margins tax, the state could move to third place, joining South Dakota and Wyoming as the only states without an income tax or a general business tax.

My research finds that if the explicit margins tax liability and implicit compliance cost are abolished, then Texas could have increases of $16 billion in new personal income and 130,000 new private sector jobs above the status quo within the first five years. Even the most conservative estimates from other studies indicate that Texas could gain billions of dollars in new personal income and tens of thousands of new private sector jobs.

The Texas Comptroller notes that businesses will still technically submit taxes in Texas. Businesses are estimated to submit 42 percent of the projected $32 billion in sales tax and 51 percent of the expected $36 billion in property taxes for school districts in FY 2019.

The 2015 Texas Legislature helped reduce this burden on people by cutting the margins tax rates by 25 percent and lessening the compliance cost for a total taxpayer savings of $2.6 billion that began January 1, 2016. The Comptroller’s preliminary estimatesshow that margins tax collections in the 2016-17 period are 18.6 percent less than in the prior period, so less than the cut in rates even with slower economic growth from less mining activity, a weaker global economy, and other economic factors.

The evidence is clear: Texans are poorer every day that the margins tax exists. Eliminating it as quickly as possible, maybe by combining both bills above, would enhance Texas’ prosperity. This leadership in Texas, where almost one-third of jobs have been created since December 2007, should encourage Congress to control government spending and end the federal corporate income tax.